What is the VAT Flat Rate Scheme?

The VAT Flat Rate Scheme Explained

The VAT Flat Rate Scheme (FRS) is a simplified method of accounting for VAT designed for small businesses. Instead of calculating VAT on each individual sale and purchase, businesses on the FRS pay a fixed percentage of their gross turnover (including VAT) to HMRC.

The scheme reduces the administrative burden of VAT accounting and can sometimes result in a lower VAT bill, depending on the nature of the business.

How the Flat Rate Scheme Works

Under the standard VAT method, businesses charge VAT on sales (output tax), reclaim VAT on purchases (input tax), and pay the difference to HMRC. Under the FRS:

1. You still charge VAT at the standard rate (20%) on your invoices to customers
2. You do not reclaim VAT on most purchases
3. You pay HMRC a flat rate percentage of your gross turnover (VAT-inclusive)
4. You keep the difference between the VAT you charge and the flat rate you pay

Example

A management consultant on the FRS with a flat rate of 14%:

In this case, the business keeps £32 — the difference between the £200 VAT charged and the £168 paid to HMRC.

Eligibility

To join the Flat Rate Scheme, your business must:

• Have a VAT-taxable turnover of £150,000 or less (excluding VAT) in the next 12 months
• Be VAT-registered (the FRS is not a separate registration)

You must leave the scheme if your total business income exceeds £230,000 in any 12-month period (including VAT and non-VAT income).

The scheme is not available to businesses that:

• Have left the FRS in the previous 12 months
• Are closely associated with another business
• Are already using the VAT margin scheme or capital goods scheme
• Are not up to date with their VAT returns and payments

Flat Rate Percentages

HMRC assigns a flat rate percentage based on your business sector. Some examples:

The full list is available on GOV.UK and covers over 50 sectors.

First-Year Discount

Businesses in their first year of VAT registration receive a 1% discount on the flat rate. Using the example above, the consultant would pay 13% instead of 14% in their first year.

Limited Cost Traders

Since April 2017, businesses classified as limited cost traders must use a flat rate of 16.5% regardless of their sector. A limited cost trader is one that spends less than:

• 2% of gross turnover on relevant goods, or
• £1,000 per year (if 2% of turnover would be less than £1,000)

Relevant goods include physical items used by the business but exclude:

• Capital expenditure
• Food and drink consumed by the business or its employees
• Vehicles, vehicle parts, and fuel (unless operating in the transport sector)

The limited cost trader provision significantly reduces the benefit of the FRS for service businesses with minimal goods purchases. Many consultants, IT contractors, and professional service firms fall into this category and find the FRS is no longer advantageous.

Capital Assets

While you generally cannot reclaim VAT on purchases under the FRS, there is an exception for capital assets costing £2,000 or more (including VAT) in a single purchase. For these items, you can reclaim the input VAT separately, in addition to paying the flat rate on your turnover.

This is claimed on the same VAT return as your flat rate calculation.

Advantages of the Flat Rate Scheme

• Simplified accounting — no need to record VAT on every purchase
• Reduced admin — less time spent on VAT returns
• Certainty — you know exactly what percentage of turnover goes to HMRC
• Potential saving — if your sector rate is low relative to your input VAT, you may pay less than under standard VAT
• Cash flow — if you charge 20% but pay a lower flat rate, you retain the difference
• First-year discount — an extra 1% reduction in the first year of VAT registration

Disadvantages of the Flat Rate Scheme

• Cannot reclaim input VAT on most purchases (except capital assets over £2,000)
• Limited cost trader rules mean many service businesses pay 16.5%, which is often more than standard VAT
• Not suitable for businesses with significant VATable purchases — you would be better off reclaiming VAT under the standard method
• Turnover cap — must leave the scheme if turnover exceeds £230,000
• Zero-rated and exempt supplies are included in the flat rate calculation, even though no VAT is charged on them

When the Flat Rate Scheme Makes Sense

The FRS tends to benefit businesses that:

• Have low goods costs relative to turnover but are not classified as limited cost traders
• Value simplicity over potential savings
• Sell mainly to consumers (B2C) rather than VAT-registered businesses
• Are in sectors with low flat rates relative to the standard 20% VAT rate

The FRS is generally not beneficial for businesses that:

• Are limited cost traders (16.5% rate)
• Have significant input VAT to reclaim
• Export goods (zero-rated sales still form part of the flat rate calculation)
• Are growing towards the £230,000 threshold

Joining and Leaving the Scheme

How to Join

Apply online through your VAT online account or by contacting HMRC. You can start using the scheme from the beginning of your next VAT period after approval.

How to Leave

You can leave the FRS at any time by writing to HMRC. You must leave if:

• Your total business income exceeds £230,000 in any 12-month period
• You are no longer eligible (for example, you use the margin scheme)

When leaving, switch to standard VAT accounting from the start of your next VAT period.

FRS and Making Tax Digital

Businesses on the Flat Rate Scheme must still comply with Making Tax Digital requirements. This means maintaining digital records and submitting VAT returns through MTD-compatible software, even though the VAT calculation itself is simpler.

Record Keeping

Even under the FRS, you must keep proper accounting records . While you do not need to record input VAT on every purchase, you still need to maintain:

• Records of all sales and the VAT charged
• Records of all purchases (for income tax or corporation tax purposes)
• Calculation of your flat rate VAT each quarter
• Evidence of any capital asset VAT claims
• Records to demonstrate whether you are a limited cost trader